1 PowerPoint Presentation by Douglas Cloud Professor Emeritus of Accounting Pepperdine University © Copyright 2005 South-Western, a division of Thomson Learning. All rights reserved. Task Force Image Gallery clip art included in this electronic presentation is used with the permission of NVTech Inc. Managing Multi- Divisional Organizations Chapter M10

2 Exhibit 1 The Pulp Manufacturing Process

3 Exhibit 2 The Paper Manufacturing Process

4 Objective 1 Explain problems associated with managers acting on behalf of owners. Once you have completed this chapter, you should be able to:

5 Theoretical Framework for Behavior Within Organizations Agents are hired by owners and are expected to manage the company in a way consistent with the owners’ interests.

6 Theoretical Framework for Behavior Within Organizations Economic theory assumes that the objective of a company is to maximize stockholder wealth.

7 Theoretical Framework for Behavior Within Organizations However, economic theory does not assume that managers will always behave in a way consistent with owners’ interest.

8 Objective 2 Identify various organizational levels within a company and explain how performance at each level may be evaluated. Once you have completed this chapter, you should be able to:

9 Exhibit 3 American Paper Company—Organizational Chart

10 Management of Decentralized Organizations Managers typically are evaluated on the basis of variables over which they have control.

11 Management of Decentralized Organizations Divisions within an organization often are categorized according to the type of responsibilities placed on managers.  Cost centers  Revenue centers  Profit centers  Investment centers

12 Management of Decentralized Organizations A cost center is a division of an organization that consumes resources while performing its responsibility, yet has no direct involvement in generating sales or acquiring property. Managers of cost centers are evaluated on their ability to control costs.

13 Management of Decentralized Organizations A cost center is a division of an organization that consumes resources while performing its responsibility, yet has no direct involvement in generating sales or acquiring property. Managers of cost centers are evaluated on their ability to control manufacturing costs. Performance Measures: Manufacturing costs (material, labor, overhead) Quality (defect rate) Percentages of on-time deliveries Performance Measures: Manufacturing costs (material, labor, overhead) Quality (defect rate) Percentages of on-time deliveries

14 Management of Decentralized Organizations A revenue center is a division of an organization that has responsibility for generating sales. Revenue center managers should be evaluated using sales, rather than income, as a performance criterion.

15 Management of Decentralized Organizations A revenue center is a division of an organization that has responsibility for generating sales. Revenue center managers should be evaluated using sales, rather than income, as a performance criterion. Performance Measures: Sales volume in units Inventory turnover Sales revenue Performance Measures: Sales volume in units Inventory turnover Sales revenue

16 Management of Decentralized Organizations A profit center is a division of an organization that is responsible for both generating sales and controlling costs and expenses. Profit center managers typically have the responsibility for setting prices for products, determining product mix, and monitoring production activities.

17 A profit center is a division of an organization that is responsible for both generating sales and controlling costs and expenses. Management of Decentralized Organizations Profit center managers are responsible for costs, sales volume, and profitability. Performance Measures: Manufacturing costs Distribution costs Sales volume Profitability Performance Measures: Manufacturing costs Distribution costs Sales volume Profitability

18 Management of Decentralized Organizations An investment center is a level within an organization that has the strategic responsibility for generating profits and managing assets. Investment center managers are responsible for improving market share and introducing new products.

19 Management of Decentralized Organizations An investment center is a level within an organization that has the strategic responsibility for generating profits and managing assets. Investment center managers are responsible for improving market share and introducing new products. Performance Measures: Return on investment Market share Successful new product introductions Performance Measures: Return on investment Market share Successful new product introductions

20 Objective 3 Explain the historical context in which return on investment (ROI) was developed. Once you have completed this chapter, you should be able to:

21 Return on Investment (ROI) Operating Income Sales Margin x Sales Average Operating Assets Turnover Margi

22 Operating Income Sales Margin = Sales – (cost of goods sold + operating expenses) Return on Investment (ROI)

23 Return on Investment (ROI) Operating Income Sales Margin x Sales Average Operating Assets Turnover Turn

24 Sales Average Operating Assets Turnover = Investments in cash, accounts receivable, inventory, and plant assets used in production Return on Investment (ROI)

25 Objective 4 Calculate ROI and economic value added. Explain how they can motivate behavior that is consistent or inconsistent with the strategic objectives of an organization. Once you have completed this chapter, you should be able to:

26 Exhibit 5 Return on Investment (ROI) American Paper Company’s Pulp Division Before Cost-Cutting Program Operating Income Sales Margin x Sales Average Operating Assets Turnover $48,000,000 $800,000,000 $750,000, x 1.07 ROI = 0.064

27 American Paper Company’s Pulp Division Before Cost-Cutting Program Operating Income Sales Margin x Sales Average Operating Assets Turnover $11,000,000 $275,000,000 $200,000, x 1.38 ROI = Return on Investment (ROI) Exhibit 5

28 American Paper Company’s Paper Division After Cost-Cutting Program Affecting Margin Return on Investment (ROI) Operating Income Sales Margin x Sales Average Operating Assets Turnover $13,750,000 $275,000,000 $200,000, x 1.38 ROI = 0.069

29 American Paper Company’s Paper Division After Improving Both Margin and Turnover Return on Investment (ROI) Operating Income Sales Margin x Sales Average Operating Assets Turnover $13,750,000 $275,000,000 $175,000, x 1.57 ROI = 0.079

30 Exhibit 6 Product and Volume Diversity within the Paper Plant

31 Return on Investment Downside Short- term Decisions Managers reduce operating costs by cutting research and development expenses. Exhibit 7

32 Return on Investment Downside Managers reduce operating costs by reducing maintenance expenditures. DENIED Exhibit 7 Short- term Decisions

33 Return on Investment Downside Long- term Effects Cutting R & D expenses may cause less competitive products to be produced. Exhibit 7

34 Return on Investment Downside Reducing maintenance costs may result in large equipment repairs or replacement. Long- term Effects Exhibit 7

35 Economic Value Added Compared to ROI Crimson Company’s investors require a 20% return on their invested capital. The division manager of the Western Division employs invested capital of $1,000,000.

36 Sales$2,000,000 Cost of goods sold 1,300,000 Gross profit$ 700,000 General selling and administrative costs 450,000 Operating income$ 250,000 Cost of capital (.20 x $1,000,000) 200,000 Economic value added$ 50,000 Residual Income Calculation for the Western Division Exhibit 8

37 ROI = ÷ Operating income Average operating assets ROI =$250,000 ÷ $1,000,000 ROI =.25 Economic Value Added Compared to ROI

38 Objective 5 Discuss the four elements of the balanced scorecard approach to evaluating performance. Once you have completed this chapter, you should be able to:

39 Balanced Scorecard Approach The balanced scorecard has key performance criteria in four categories. Financial Customer satisfaction Internal business processes Learning and growth

40 Financial performance measures motivate managers to consider how the company looks in the eyes of the shareholders. Balanced Scorecard Approach Financial Customer satisfaction Internal business processes Learning and growth

41 Balanced Scorecard Approach The balanced scorecard contains a category of indicators that encourage managers to consider how their company looks in the eyes of customers. Percentage of on-time deliveries Customer response time Financial Customer satisfaction Internal business processes Learning and growth

42 Balanced Scorecard Approach Internal business indicators include measures that promote manufacturing excellence, such as cycle time, scrap rate, and lead time from placing an order until delivery. Financial Customer satisfaction Internal business processes Learning and growth

43 Balanced Scorecard Approach Common objectives for the learning and growth category include improving employee skills through training,... Financial Customer satisfaction Internal business processes Learning and growth

44 Balanced Scorecard Approach …providing adequate resources to employees who strive to meet difficult targets,... Financial Customer satisfaction Internal business processes Learning and growth

45 Balanced Scorecard Approach …empowering employees to make decisions, and motivating employees with meaningful rewards when goals are met. Financial Customer satisfaction Internal business processes Learning and growth

46 Performance Measures Using the Balanced Scorecard Approach for the Paper Division of American Paper Company Exhibit 10

47 Perspective Actual Desired Perspective Actual Desired Financial ROI Customer On-time deliveries80%85% Response time to inquiries2 days3 hours Internal Business Processes Cycle time6 weeks5 weeks Scrap rate5%2% Manufacturing lead time10 hours8 hours Learning and Growth Percentage of employees with specialized training or skills8%25%

48 Objective 6 Explain how a manager who acts in the best interests of a division may harm the company as a whole. Once you have completed this chapter, you should be able to:

49 Transfer Pricing Transfer pricing involves setting appropriate selling prices for goods or services when both buyer and seller are within the same company.

50 The classical transfer pricing problem involves setting a pricing policy... Transfer Pricing

51 …that encourages managers to act in the best interest of the overall organization. Transfer Pricing

52 Objective 7 Discuss various transfer pricing methods that have been developed to influence managerial decisions. Once you have completed this chapter, you should be able to:

53  Market-based pricing policies require buyers and sellers to transfers goods based on externally verifiable market prices. Transfer Pricing  Cost-based pricing policies use either full cost or variable cost as a basis for determining a transfer price.

54  Negotiated transfer pricing policies permit managers to consider factors such as cost and external market prices when negotiating a mutually acceptable transfer price between two business entities. Transfer Pricing

55 If a division has excess capacity, a transfer price between the variable cost of the selling division and the outside market price may be negotiated. Transfer Pricing

56 Cost-based Strengths: Cost-based transfer pricing methods are easy to apply because standard (or actual) product costs generally are available from the accounting system. Weaknesses: Cost-based transfer pricing methods do not encourage and reward efficiency. Transfer Pricing

57 Market-based Strengths: Market-based transfer pricing methods force departmental managers to be as cost-efficient as the best competitor. Weaknesses: Market-based transfer pricing methods require time and effort because external bids must be acquired and evaluated. Transfer Pricing

58 Negotiated Strengths: Negotiated transfer pricing methods encourage dialogue among division managers. Weaknesses: Negotiated transfer pricing methods take management time and can result in stronger negotiators acquiring better deals (performance may be affected by negotiating skills). Transfer Pricing

59 Objective 8 Explain how the performance of managers can be evaluated in decentralized service organizations. Once you have completed this chapter, you should be able to:

60 Management of Decentralized Service Organizations Decentralized service organizations can be made up of cost centers, profit centers, revenue centers, and investment centers.

61 Management of Decentralized Service Organizations Transfer pricing is a major issue in banking. Banks must maintain a certain ratio of loans to deposits. Funds are transferred from branches with excess funds to branches that have exceeding their loan-to deposit ratio limit. ContinuedContinued

62 Management of Decentralized Service Organizations The interest rate selected for the transfer of funds is similar to the the transfer price in a manufacturing organization.

63 THE END Chapter M10

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